Weekly Wrap

Market Update

Calendar Icon Friday, 30th April 2021

ASX 200 Index (XJO)

We mentioned last week that the XJO rejected lower prices around the 6900 level and since then the index has hit a 14 month high at 7096. On the chart below we can see that the XJO has been trading in a channel from last November. Given that the XJO is trading at the higher end of the channel, the implication is tending towards higher prices.

6900 is the key level for the XJO. Any break below this would increase the bearish case. Until that happens, the previous high is 7197 and there is a strong chance that the XJO will attempt to reach it.

Is Inflation Back?

Interest rates have been climbing steadily since last October, especially in America.Is the bond market alerting us to the fact that inflation and rising rates are back?

One way to judge if the bond market is flashing alarm bells is to look at the TIPS bond market.

TIPS are defined as:

Treasury Inflation-Protected Security (TIPS) is a Treasury bond that is indexed to an inflationary gauge to protect investors from the decline in the purchasing power of their money. The principal value of TIPS rises as inflation rises while the interest payment varies with the adjusted principal value of the bond.

The TIPS market has been ignored for some time as the investment community has not been dealing with a dis-inflationary environment.

For the first time in several years, inflation is becoming a genuine concern that investors need to worry about. That’s not to suggest that inflation rates are about to begin skyrocketing, but certain sectors of the economy are already showing notable price increases and the Treasury yield curve is reflecting those risks.

The 5-year breakeven rate, a measure of forward-looking inflation expectations, is at its highest level since 2012.

One key way to gauge whether inflation is back is to look at the correlation with the commodity market. We can see on the chart below that crude oil (which is the biggest component of the CRB commodity index), actually went into negative territory last year when pandemic fears were at the highest. Since then crude has managed to rally hard to sit around the US$60/bbl.

Note the chart below and the arrow is pointing to the past 12 months, which has been the biggest money printing time in US history. Crude has actually been unable to break out of the long-term downtrend despite the massive inflationary stimulus.

The American economy is at an important tipping point. Either the monetary stimulus will push commodity prices higher (including crude), or the ‘sea of money’, will crush the rally and push crude back to former lows.

Currently the Biden administration is determined to keep pumping money into the economy. They continue to make noise about industrial legislation reforms and reducing the power of the massive tech stocks. On the one hand they want to keeping priming the pump, but on the other they appear intent to curb the high growth sectors of the economy.

It is a fine balancing act that history has shown is hard to maintain. The bond market is giving us an early warning and the TIPS are at their highest level since 2012.

Crude oil Adjusted for money supply

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